Investing in Companies like Peter Lynch

Peter Lynch was one of the greatest and most successful investors on Wall Street, having generated a 2700% return for the Magellan Fund from 1977 until his retirement in 1990.

Here is how he decided on which companies to invest

He categorized companies in one of the six categories
1. Slow Growth
2. Stalwarts
3. High Growth
4. Cyclical
5. Turnarounds
6. Asset plays
1/ Slow Growth
- Large and aging companies expected to grow slightly faster than GDP. Used to be fast growers until they reached their maximum possible expansion and lost momentum or their industry at large lost momentum
- Every popular fast-grower becomes a slow grower sooner or later
- Pay a generous and regular dividend
- Consistent dividend payments, increased over time
- Payout ratio - low => company has cushion for hard times, high => risky dividend
- 30-50% appreciation or fundamentals have deteriorated
- Company has lost market share in recent years
- No product development, or product research
- Acquisitions do not seem to be helpful
- Balance sheet has deteriorated
- Not high enough dividend yield
2/ Stalwarts
- Focus on P/E if price has increased sharply in recent months, and actions that accelerate growth rate
- Stock selling at its low end of P/E, increased growth rate, market expansion
- Price and P/E ratio low, lower than the industry average
- Diversifications that might reduce earnings
- Long-term growth rate, kept momentum over recent years
- How company has fared during previous recessions and market drops
- No point expecting a quick ten-bagger in a stalwart
- Stock price above earnings line, P/E higher beyond normal range
- New products not very successful
- P/E higher compare to similar quality companies in the industry
- No share buybacks
- Major division, with high contribution to company's earnings, vulnerable to economic slump
- Growth rate slowing down, limited cost-cutting opportunities in the future
3/ High Growth
- Focus on the possibility for further growth and expansion
- Company has successfully duplicated its formula in other areas
- Earnings have increased every quarter
- Rapid future expansion planned
- No/low debt
- Company in low-growth industry, but has a niche against competition
- Long way before saturates the market
- Impact of a successful product on the company's earnings
- Earnings growth rate (20-25%) - avoid hot companies in hot industries (>50%)
- Successful duplication (cloning) of business operation in other locations
- Room for expansion and further growth
- P/E at or near growth rate
- Expansion speeding up or slowing down
- Few institutions own the stock, few analysts follow it
- Company falls apart, earnings shrink
- End of second phase of rapid growth
- Sales declining
- New stores not very successful
- Talent drain to other competitors
- Company desperate for outside investors
- P/E much higher than projected earnings growth
4/ Cyclical
- Focus on business conditions, inventories, prices
- There has been a decline in the industry, but things are turning around
- New products/services have been selling lately
- Company has shut down inefficient, loss-making departments, subsidiaries, reduced costs
- Earnings are about to increase
- Inventories and supply-demand relationship. Watch for new entrants/competitors
- Anticipate shrinking P/E over time when business recovers and investors look ahead to the cycle end when peak earnings are achieved
- Figuring out the cycle in the industry
- Towards the cycle end
- Rising inventories
- New competitors in the market
- Union contracts about to expire soon
- Product demand slowing down
- Increased capital spending
- Can't compete with foreign producers
5/ Turnarounds
- Focus on the company's efforts to increase fortune and plan execution so far
- Company has made progress reversing the adverse effects of its diversification, has closed/sold departments
- Company buys back shares
- Earnings are up sharply
- New products released increased earnings and market share
- Cash and debt
- If bankrupt, what's left for shareholders
- Rid of unprofitable divisions, restructuring
- Turnaround in the sector in general
- Cost reduction
- After turnaround, problems resolved
- Stock needs to be reclassified after turnaround
- Rising debt
- Inventories increase rate higher than revenue growth rate
- P/E inflated relative to earnings prospect
- Company relies heavily on one customer
6/ Asset Plays
- Focus on assets and their worth
- Stock price low, but the asset value of a division or of the property is a high percentage of it
- Company has steady earnings and no debt
- Asset value, hidden assets
- Assets to debts ratio
- Company not acquiring new debt
- Is there a way for shareholders to reap the benefits of assets?
- Wait for the raider
- New share issuance announced to finance diversification
- Divisions or assets sold for less than expected asset value
- Tax-rate reduction reduces tax-loss carry-forward
- Increased institutional ownership

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